Counterparties and credit ratings
We work closely with leading global investment banks, utilising the strong relationships that we have developed, to create a diverse range of financial products.
In a market where the future is unknown and security is of concern, using counterparties with a high level of financial strength is one of the many factors we consider when assessing a potential counterparty. The safety of any investment depends on the strength of the underlying counterparty and its continued solvency throughout the term of the investment. Whilst there are no definitive rules about how to assess this risk, Meteor considers the financial strength of any prospective counterparty before doing business with them. There are a number of tools available to assist this process.
Historically, investors have relied upon Credit Rating Agencies to determine the financial strength of counterparties. Events in recent years have demonstrated that whilst the agencies are a valid point of reference in assessing the strength of counterparties, they cannot be relied upon in isolation. We consider a number of factors, including, but not limited to, credit rating, credit default swap rates, financials and company structure of the counterparty (including shareholders), its structuring ability, its willingness to provide a competitive price, its jurisdiction for regulatory purposes and its commitment to providing quality post-sale service for investors, including regular pricing.
Assessing counterparty risk is a balancing process; no single factor should be considered in isolation. We actively monitor existing and potential future counterparties to identify any risk of counterparty failure. Generally, the risk of a major financial institution failing to meet its commitments is considered small. However, it is possible, so investors must be aware of, and understand, this risk.
The counterparty issues the financial instrument(s), which deliver the potential investment returns as defined in the product literature. This includes the repayment of capital and any potential growth and/or income payments. If the counterparty were to collapse or failed to make the payments due, an investor could lose some or all of their original investment as well as any possible returns from the product to which they might otherwise have become entitled.
We disclose the identity of the counterparty backing the product in the literature, their credit rating at the time the product is launched, as well as general details about the counterparty. We would not use any counterparty that objects to full disclosure of their identity for marketing purposes.
Being an independent company, we have no institutional bias towards any single counterparty and can therefore provide a diverse range of products, with varying degrees of counterparty risk. This can be of great benefit to investors, and separates us from most of our competitors, which are often linked to an associated bank or a single counterparty.
Higher headline rates can be achieved through the use of weaker counterparties due to the higher cost of funding from counterparties with lower ratings, but investors should differentiate between products driven by headline rates and those potentially offering a better value investment with a counterparty offering a high level of financial strength.
Investors should diversify their portfolio by not investing the majority of their money with a single counterparty (otherwise known as concentration risk). Meteor provides an opportunity to diversify, by offering products from a range of highly rated counterparties.
We believe that it is important that investors and their advisers make sure an investment is suitable. Meteor does not provide financial advice or guidance on tax, legal, or investment issues. We strongly recommend that investors talk to a financial adviser before deciding whether to apply for a particular plan. To gain a full understanding of one of our products, it is important that investors read the brochure carefully, including the terms and conditions.
It is important for Meteor to assess the ‘creditworthiness’ of any potential counterparty before doing business with them.
Credit ratings are considered one of many indicators of the financial strength of an institution, by indicating the credit rating agency's view of the capacity of the counterparty to honour its obligations.
Credit ratings are assigned by independent organisations known as credit rating agencies, such as Standard & Poor’s, Moody’s, and Fitch.
Ratings are normally in the form of letter designations (e.g. AA). For further information on the definitions of the ratings assigned by each agency please refer to their websites:
Meteor will only consider potential counterparties with a current rating of at least ‘A’ from one of these 3 agencies (unless specifically requested to consider a lower rated institution by an investor for a bespoke product).
Credit ratings are merely opinions of an institution’s overall financial capacity to meet its financial commitments – they do not apply to any specific financial obligation – and they are not a guarantee of financial strength, or a recommendation to purchase, sell, or hold a financial obligation.
Credit rating agencies assign credit ratings based on their views of the ‘worst possibilities’ in the ‘visible future’ for the institution. They do not base their opinion on the past record or present status of the institution.
Credit Default Swap rates
A CDS is basically an insurance contract - the buyer makes periodic payments to the seller for effectively insuring against a debt default, and in return receives a payoff if the underlying financial instrument does default.
In recent years Credit Default Swap (‘CDS’) rates have become an additional measure of the financial security of a company and are now often utilised alongside ratings produced by credit rating agencies.
CDS rates levels are determined by the supply and demand of market participants and therefore do not rely on a single agency to determine a company’s credit worthiness.
CDS spreads allow investors to analyse how risky an institution’s debt is perceived to be by the market, a relevant factor when considering the credit strength of a counterparty.
CDS rates indicate the percentage above London Interbank Offered Rate (‘LIBOR’) that buyers are willing to pay a seller in order to insure themselves against the likelihood of a credit default event of the underlying issuer.
Companies with higher CDS spreads are considered riskier by the market – they are considered more likely to default than those with a lower CDS spread, all other things being equal.
At Meteor, we consider not only the current CDS spread compared to similar counterparties, but also the recent movement in CDS rates, as this is often a stronger indicator of creditworthiness than looking at the current CDS spread in isolation.
For the current CDS rates, please visit this page.
Financial statements, ratios and company structure of counterparties can be an indication of their future financial condition and operating performance.
Financial statements provide a snapshot of a counterparty’s financial status at a specific point in time and performance over a specified time period. Financial ratios can be used to compare one counterparty’s risk and return profile with that of other counterparties and also to assess movement in these ratios over time. At Meteor we use ratio analysis to evaluate a counterparty’s profitability, liquidity, and solvency.
We monitor ratios such as profit margin, return on equity, return on assets and earnings per share to analyse the counterparty’s use of its assets, and its ability to generate an acceptable rate of return.
Liquidity ratios provide information about a counterparty’s ability to meet its short term financial obligations. This is particularly important when determining the financial strength of a counterparty, as it indicates their ability to make payments due during periods of economic stress. We monitor the current ratio, quick and cash ratios, as well as the source of the counterparty’s funding.
Solvency ratios provide information about a counterparty’s ability to meet its long term obligations. We monitor debt to equity, debt to assets, coverage of fixed costs, and interest coverage.
Capital ratios are another measure of a bank's strength and are commonly used by regulatory authorities. The most widely known is the tier one capital ratio, which consists largely of shareholders' equity. It is the amount paid originally to purchase permanent capital (such as ordinary shares) of the bank and retained earnings (minus losses). It is the core measure of a bank's financial strength from a regulator's point of view.
This ratio has been the subject of much review over recent years resulting in the Basel III Accord, requiring banks to maintain a minimum tier one capital ratio of 6%.